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You just need to be listening.
Utilities were the darlings of 2014. The group outperformed the DJIA, the S&P 500 and the Nasdaq Composite by wide margins. Most people own utility shares for "income" and refuse to trade out of them even when the shares get overpriced.
That can be a big mistake.
Typical utility shares were yielding around 3% near year end 2014. A 10% - 20% drop is equivalent to giving up as much as six years’ worth of dividend income. Worse still, those quarterly dividends are taxed in the calendar period they are received while any capital losses are deferred until shares are sold.
The S&P Utility Industry Group had a monster 2014. They finished with a flurry. The Dow Jones Utility Index (DJU) rose a whopping 3.56% in the week ended Dec. 26, 2014. It was up almost 30% plus dividends YTD at that time.
GuruFocus readers saw my article warning about utility overvaluation ... but probably ignored it. Why sell the very stocks that just finished such a smashing year?
On Monday, Dec. 29 the group briefly edged even higher. That turned out to be its all-time peak. Friday, Feb. 6, 2015, saw utilities suffer one of the group's largest single-day percentage drops in history.
Monday, Feb. 9 gave way to a further 0.88% decline. The XLU's five-week decline wiped out approximately two years of yield. And it didn't even buy you some drinks to get you in the mood to get screwed.
San Diego-based Sempra Energy (SRE, Financial) is a good proxy for understanding just how pricey the industry had become. Its year-end 2014 P/E was double where it sat from 2008 through 2011. The best buying opportunities during those years came at multiples of just 7.8x – 10.9x.
Sempra’s late 2014 yield was the worst (lowest) since early in 2008. Buy-and-hold types who sat tight at 2008’s peak had to wait more than four years just to get even.
SRE has already pulled back by 6.2% from its December pinnacle. How much risk could be left? A lot. ZIRP (Zero Interest Rate Policies) can only blind people for so long.
Sempra has been the opposite of a growth company. EPS were lower in 2014 than they were in 2009. SRE’s annual dividend increases came only via expansion of the firm’s payout ratio.
If Sempra earns the expected $4.75 this year and reverts back to its average P/E the shares could sink to under $70. Don’t laugh. SRE plunged from $63.00 in 2008 to $34.30 during that same year.
Value Line assumed a 14.5x P/E in figuring their 3 – 5 year target range. Note that those meager total return projections figured final year EPS of $6.25, a longshot based on Sempra’s history. They also include all expected cash dividends.
If you don’t favor my analysis technique, or Value Line’s, check out Morningstar’s view. They cold-bloodedly call Sempra a SELL while laying out a $90 fair value estimate. If almost $28 of downside still earns 2-stars... I wonder what it would take to garner a 1-star rank.
Realistic holders of most other utility shares will see similar over-valuations along with lower than typical yields.
The click ad below fails to note the danger while promoting the diversification factor. Spreading your money among many pricey Utes is unlikely to help, though.
It is not too late to sell.
Disclosure: No position in utility stocks
